IRA non-deductable to a Roth
I have a client that has only one IRA where all contributions are post tax. To use round numbers the total value is $100,000 and her basis is $40,000. They do not want to convert the whole amount and pay taxes on $60,000. If they converted $25,000 a year would the tax be pro rated 60% taxed and 40% tax free or is the gain taxed first?
Permalink Submitted by Alan Spross on Tue, 2011-04-19 22:43
The taxable amount is pro rated, ie for a 25k conversion, the taxable amount would be 15k. After the first 25k conversion, the remaining basis drops to 30k and the TIRA balance to 75k.
From there, assuming no more contributions or other distributions, if there are investment gains, the taxable % goes up and if there are losses, the taxable % drops.
Note that the taxable % can change after the conversion since it is based on the year end adjusted values, not the values on the day of the conversion. Therefore, if the conversion is done now, and the remaining TIRA value gains for the rest of the year, the taxable % of the conversion will go up.
That said, if it goes up too much, a portion of the conversion can always be recharacterized so that the tax cost of the conversion can be controlled.
All of this is calculated on Form 8606, and of course the client had to have filed the 8606 in the past for each year a non deductible contribution was made. If they did not do that, it will have to be done retroactively for the IRS to recognize the basis in the TIRA.
Conversions are more compelling the higher the % basis is for the TIRA. 40% is a high basis, so conversions are more likely to be advisable than if the client had no basis.